Presented to:NARUC Joint Panel
Consumer Affairs/Gas CommitteesWashington, DCMarch 9, 2004
Natural Gas Market Monitoring andRecent Price Increases
William F. Hederman, DirectorOffice of Market Oversight and Investigations
Federal Energy Regulatory Commission
WH-3/9/04
2
Outline
• FERC’s Overall Strategy• Market Monitoring (OMOI)• Current Challenges• Confidence building
-- February 2003 price spike investigation
-- Price index/reporting initiative
-- Winter 2003-04 price ramp-up• Conclusion
3
FERC has a 3-pronged strategy.
Effective Rules
Infrastructure
Rules
Enforcement
CompetitiveMarkets
Just & ReasonableOutcomes
StrategicApproach
4
Market Oversight:the Necessary Feedback Loop
• Why a Feedback Loop is Essential
- Markets not perfect
- Companies are paid to find advantage
- Leads to dynamic forms of efficiency – and market power
- Stakes are unusually high
• What a Feedback Loop Needs to Be and Do
- Lead to changes in market structure and rules
- Uncover and respond to abuse
- Find problems in details of the market
- Also find problems in inter-connections of markets
• The Bottom Line: Good Walls make Good Neighbors => Good
Regulators make Good Markets
5
Director
Office of Market Oversight and Investigations (OMOI) - Knowledge/Skillsets
Division of Management & Communication
Division of Management & Communication
• Planning • Perf. Mgmt. • Budgeting • Facilitation • Speaking • Knowledge of industry • Partnering
• Career Dev. • HR • Recruiting • Contracting • Writing/Editing • Web design • Graphics • Presentation development
Deputy Director Market
Oversight & Assessment
Deputy Director Market
Oversight & Assessment
Deputy Director Investigations & Enforcement
Deputy Director Investigations & Enforcement
HotlineHotline
Division of Energy Market
Oversight
Division of Energy Market
Oversight
Division of Financial
Market Assessment
Division of Financial
Market Assessment
Division of Integrated
Market Assessment
Division of Integrated
Market Assessment
• Public Speaking • ADR • Phone answering
• Attorneys • Litigation • Investigation • Knowledge of financial markets • Enforcement • ADR Training • Paralegal
Division of EnforcementDivision of
Enforcement
Division of Operational
Investigations
Division of Operational
Investigations
Division of Technical
Investigations
Division of Technical
Investigations
• Forensic Auditors • Analytic ability • Statistical sampling • Documentation • Industry experience • Investigators • Examiners
• Gas Engineer • Electric Engineer • Mechanical Engineer • Quantitative Economist
• Electrical Engineers • Pipeline Engineers • Economists • Deep Industry Expertise • Information Analysis • Modeling • Operations Research • Market Design & Operation
• Engineers • Economists • Broad Industry Experience (Cross- Industry, Scenario, Regulatory Analysis; Market Microstructure Issues) • Operations Research • Writing/Presentation Skills • Policy Analysts
• Information Analysis • Energy Industry Expertise • Software Applications (Large databases, Data Analysis, Statistical, Presentations (including Mapping) • Web Experience • Questionnaire & Survey Design • Statistical Analysis
Market ScanningMarket
Scanning
• Strategic Analysts • Library Science
Division of Information Development
Division of Information Development
• Financial Analysts • Accountants • Understanding of Investment • Derivatives Markets • Energy Trading
6
Natural Gas & Electric Market Space
Gas Supply
Trading Venues
Futures (NYMEX)
Electronic Platforms
Bilateral Trading
Voice Brokers
Pipelines&
Storage
Players
Delivered Market
Physical Nat Gas
Generation
Transmission&
Pumped Storage
Delivered Market
Phys Electric Power
Gas to fuel power generation
RTO’s & ISO’s
Price Contributors-Fixed price buyers & sellers-Speculators
Price Takers-Indexed price buyers & sellers
Source: FERC-OMTR&OMOI
Nat Gas & Electric Derivatives
Nat Gas & Electric Clearing
7
The natural gas market has entered a period of stress.
• Production flexibility declined significantly
• Demand has changed significantly
- significant generation load growth
- significant industrial load decrease
• Fuel switching potential is less well understood than in the past but appears to be small
8
Perceptives about market conditions are sometimes confused.
2000 2001 2002 2003 2004
MarketManipulation
Prices Increase
ManipulationInvestigations
Refunds/settlements
9
FERC, through OMOI, is working hard to improve market integrity and confidence in market integrity.
• February 2003 Price Spike Inquiry/Investigation (with CFTC)
• Price index/reporting initiative
• Winter 2003-04 Price Inquiry/Investigation (with CFTC)
Physical Next Day (Gas Daily) & Futures Prompt PricesFebruary 3, 2003 - March 18, 2003
$0.0
$2.5
$5.0
$7.5
$10.0
$12.5
$15.0
$17.5
$20.0
$22.5
$25.0
$27.5
$30.0P
ric
e (
$ p
er
MM
Btu
)
Futures Settle - Prompt Month Henry Hub - GD Next Day Phys Waha - GD Next Day Phys
Chicago - GD Next Day Phys Transco - Zone 6 NY - GD Next Day Phys
Re-building confidence in markets: February Gas Price Spike Investigation
0
500
1,000
1,500
2,000
2,500
3,000
3,500
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb MarMonth
Vo
lum
e (B
cf)
1998-2002 range 2002-03 2001-02
Withdrawals of 154 Bcf and 176 Bcf for the weeks ending Feb.
21 and Feb. 28, respectively
National storage levels
Source: AGA through 4/26/03; EIA from 5/3/02 through week ending 3/28/03.
11
Re-building confidence in markets: February Gas Price Spike Investigation
• FERC OMOI/CFTC subpoenaed information from exchanges and brokerages
• FERC OMOI/CFTC team examined more than 16,000 transactions, 130,000 bids/offers
• Findings:--relatively few active buyers and sellers at the time (liquidity problem)--weather influence (cold front + sustained cold earlier + well freeze-offs)
--low storage levels--tight production capacity
--markets related to one another effectively--no evidence of manipulation from data, hotline, or trader interviews
• Trade Press response: “the size, speed, and depth of the (FERC OMOI/CFTC team) would have made an SEC ‘tiger team’ proud.” (The Desk, July 25, 2003, page 5.)
12
Price Index Background
• Sharp reduction in energy trading in 2002• Instances of index manipulation led to FERC and CFTC
scrutiny• Many companies decided not to “risk” reporting• Fewer fixed price deals, more “at index”• Price index developers had less data to create indices• Indices still essential component of markets for pricing deals;
setting royalty payments; tracking prices; settling futures contracts; hedging gas transportation costs; pricing cash-outs or penalties in tariffs; and benchmarking prudent transactions
• Need to restore confidence in indices—they must be accurate, reliable, and transparent
13
Essentials in the Policy Statement
• Focuses on near-term improvements to existing system of voluntary reporting
• Outlines standards expected of both index developers and price reporters
• Embraces “safe harbor” approach to encourage more reporting
• Prospectively requires indices in gas tariffs (i.e., for cash-outs) to meet standards and “reflect adequate liquidity”
• Directs Staff to monitor and report developments under Policy Statement
• Notes that failure of industry to respond could result in mandatory price reporting
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Standards for Price Index Developers
1. Code of conduct and confidentiality
2. Completeness—maximum information and liquidity measures
3. Data verification, error correction, and monitoring
4. Verifiability—process audit
5. Accessibility—for customers and FERC
15
Standards for Reporting Prices
1. Code of conduct—on trading and reporting
2. Source of data—independent from traders
3. Data reported—each bilateral physical trade, with price, volume, buy/sell indicator, delivery/receipt location, date and time, term
4. Error resolution process
5. Data retention and review—3 year retention, independent audit
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Safe Harbor
• Companies that establish processes to follow reporting standards are presumed to be reporting in good faith, and will not be penalized for inadvertent errors
• Presumption is rebuttable, FERC will pursue (or refer to other federal agencies) actions that manipulate, misinform, or mislead
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Monitoring the Policy Statement
• OMOI is engaging in proactive monitoring, sending message to industry that FERC is impatient to see improvement
• Status report given to FERC at October 22 meeting
• Survey of industry on trading and reporting before and after issuance of Policy Statement conducted in October
• OMOI is meeting with trade associations to get input and encourage members to report trades
• OMOI is meeting with index developers to review adherence to standards
• Workshop on liquidity held at FERC in November
18
Survey
• Sent to 266 companies—producers, generators, traders, LDCs, utilities, industrial users
• Covers trading and reporting practices before and after Policy Statement—ten questions:
Do you trade? What do you trade? Do you report? What portion of trades are reported? Are trades reported to one or to more than one index developer? Do you report through exchanges or to publications? What transaction details to you report? Who submits the report? Do you have an audit process? Do you have a code of conduct for trading and/or reporting?
19
Liquidity Issues
• Index used in gas tariff must meet standards and “reflect adequate liquidity” at the relevant location
• Economic literature on liquidity not helpful
• OMOI must report to FERC on index publishers and liquidity January 2003
• Workshop on how to measure adequate liquidity held at FERC in November
20
Winter 2003-04 Price Inquiry
• 3 Elements:
- National price increases
- Northeast price spike
- New England generator behavior
• Joint efforts
- with CFTC (successful)
- with Connecticut state agencies (Less successful)
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
$14.00
$16.00
-800 -600 -400 -200 0 200 400 600 800
Storage Deviations from "Same Week" 5-Year Average (Bcf)
Hen
ry H
ub W
eekl
y A
vera
ge S
pot P
rice
s ($
/MM
Btu
)
Office ofMarket Oversight& InvestigationsOngoing National Issue
Prices Returning to Historical Pattern.
Q1'03
Q2.'03
Source: S. Harvey, K. Kohut, R. Martinez
Nov.'00 through Apr.'01
Q3.'03
Q4.'03
Q1.'04
last updated Mar.5,2 004
22
Conclusion
• Gas supply system likely to encounter additional stress unless weather cooperates
• Market suspicions continue and FERC/OMOI examines any credible allegations
• OMOI will continue extensive oversight of important market moves
